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Individual or retail investors typically buy or sell stocks using the custodian service provided by the broker. In such cases, the broker concerned would be in relatively full possession of the transaction details such as the buying cost, the selling price and profit made, if any.
For various reasons, institutional investors may not want this transparency and exclusivity associated with engaging only one broker or custodian. Institutional investors including sovereign funds, family funds and hedge funds would use multiple brokers and multiple custodians so that the overall picture of costs and profits would be opaque to the dealing brokers and custodians.
To illustrate, suppose a family fund, say, Chan Tai Man Foundation (CTMF), wishes to keep a low profile in its global securities dealings. It therefore engages brokers B1, B2 and B3 and custodians C1 and C2. CTMF bought some HSBC stocks at price X via B1 and instructed the stocks to be transferred to C1 for safekeeping. Later, CTMF bought some more HSBC stocks at price Y via B2 and instructed the stocks to be transferred to C2 for safekeeping. Still later, CTMF sold some of its HSBC stocks via B3 and instructed C1 and C2 to transfer the requisite HSBC stocks to B3 for settlement.
At the end of this cycle, B1 and B2 each has one purchase transaction, B3 has one sale transaction, and C1 and C2 still have some stocks left in their custody. None of the brokers or the custodians has the full picture of the quantities, costs and profits involved. By employing multiple brokers and custodians, CTMF has cast a veil over its portfolio and transactions of HSBC stocks.
Another advantage is that by keeping the choice of brokers and custodians non-exclusive, CTMF can be assured of the services it gets and the charges it pays are at a level acceptable to it. Firing one or more of its retinue of financial operators, if the service quality deteriorates or the transaction cost is no longer competitive in the market, would not seriously disrupt its investment plans or activities.
From an investor’s point of view, hedging your bets in your financial operators definitely gives you advantages and flexibility.
This article was originally published in No. 498, Newsletter in May 2017.